Question

Briefly explain why a tracker fund offers a lower risk (and potential return) than shares in a single company.

Answer 1

Tracker funds are formed to track the performance of some specific market, index or sector and give similar type of return to its investors. For example, a tracking fund is formed to track some selected index like S & P 500, where the fund manager of the fund simply tries to replicate the index. The tracker fund offers a lower risk (and potential return) than shares in a single company because it invests in diversified portfolio and we know that the diversification of stocks reduces the risk. The non-systematic risk which is specific to the shares in a single company can be reduced through diversification. A well-diversified portfolio is only exposed to systematic risk or market risk and total risk of the portfolio get reduced.